By: Chris Rowe — January 17, 2007
BUGS BUNNY MONEY PART 2
Last Tuesday I let you in on the first secret that made me successful: If you try to predict the direction of the stock market you are attempting to achieve something that no human being in history has ever accomplished on a consistent basis. Your safest bet is to not even try.
A simple strategy you may consider: Reduce the power of the stock market. Weather you are bearish, bullish or in between, you can reduce your risk significantly, while at the same time increase your profit potential by purchasing call options on your favorite leaders, without paying ANY additional money for the calls!
You may already be familiar with the first part of my strategy: a simple strategy called “covered call writing” or “selling calls” on your stock positions. What you are doing essentially is promising (by way of contract) to sell your stock to someone at a specified price. The person buying the right to purchase YOUR stock at a specified price is paying you a “premium” for that right. The contract expires on a specified date (the third Friday of each month).
Investors write covered calls primarily for the following reasons:
1. To realize additional return on their underlying stock by earning premium income; and
2. To gain some protection (limited to the amount of the premium) from a decline in the stock price.
Covered call writing is considered to be a more conservative strategy than outright stock ownership because the investor’s downside risk is slightly offset by the premium he receives for selling the call.
Here's How You Can Take Control:
STEP 1 – Sell half of your stock & lock in half of your profits. Enjoy them. Take someone out to dinner tonight! Reduce your exposure by 50%. Sleep well. you can still make huge profits with STEP 2 & 3.
STEP 2 – Sell covered calls which expire 2-3 months out on your remaining stock positions which will have fresh money deposited in your stock account.
Step 3 - Use the fresh money deposited in your account (as a result of STEP 2) to purchase short term calls that expire in 2-3 months on other leading stocks.
If you are in love with only 1 or 2 stocks that you don’t already own, then concentrate the fresh money in those 1 or 2 stocks!
A Very Simple plan that literally cuts your risk in half!
- If the market sells off, then you have sold half of your portfolio. You can always implement the same options strategy a thousand S&P points lower…. With half of the loss!
- If the market crashes, you can be "that guy" at the next cocktail party that we all love, bragging that you sold out before the crash and are buying all the stock now that your friends are puking up at low prices.
You didn't lose your shirt so someone like me can "accidentally" spill their drink on it after listening to you yap for over 90 seconds.
(In a crash, you can even sell more calls to pay for Puts which explode when the market gets crushed- But that is a topic for another time.)
- If the market rallies (which is likely after breaking a 4 year high on a sharp spike in volume), the calls that you purchased can trade up 2-15 times your purchase price!
If the stock you own gets called away you will be sitting on lots of cash as well as explosive profits from the calls you purchased.
At that point you have three choices:
1) Use that cash to buy stock (call stock away) from the guys who sold you the speculative call options that you purchased in step THREE. You will automatically have a nice profit because you will own stock lower than it is currently trading.
2) Use the cash to roll into more short term calls if you are confident and brave (and greedy).
3) Use the cash to invest in nano-technology by purchasing one of those new stain proof dress shirts for the next party if you manage to get invited.
Note to the Greedy:
The more bullish you are you can adjust your strategy accordingly. You could, of course, not sell ANY stock, and implement the strategy above. All you are doing is selling calls on half of your stock and purchasing Speculative calls on stocks you like. If you are right and the market rallies, half your stock gets called away at a profit, half your stock continues rallying with the market, and you own a ton of call options that are exploding in value. You are my hero.